Corporate > AG Deal Diary > Executive Compensation Considerations for 2014
24 Dec '13

Executive compensation is a topic that just won’t go away, particularly with pay disparity and pay for performance regulations still looming.  We highlight below some of the matters directors should be considering as they craft executive compensation for 2014:

  • Say-on-Pay Vote.  Say-on-pay proposals, now in their third year, have led to what seems to be routine approval of C-suite compensation for the vast majority of companies, with shareholders at 97 percent of U.S. companies approving executive pay packages and 72 percent of such companies achieving more than 90 percent approval.1  But boards are not letting down their guard.  According to a recent survey, 70 percent of directors say their boards took some form of action in response to their company’s most recent say-on-pay vote, with the most common being enhancing proxy statement disclosures, increasing the use of compensation consultants and making compensation more performance based.2  But this does not mean that executive compensation is decreasing.  Only three percent of directors surveyed say their company reduced executive compensation during 2013.3
  • Proxy Advisory Firm Recommendations.  Proxy advisory firms can be a key driver to the outcome of a say-on-pay vote.  Companies need to analyze their shareholder base to determine the level of influence proxy advisors have on their investors.  And if a proxy advisory firm gives a negative recommendation, companies need to consider whether they want to refute the recommendation through supplemental proxy filings and shareholder outreach.  Filing supplemental materials gives companies an avenue to address inaccuracies in the proxy advisory firm recommendation and to further strengthen their case.  However, because supplemental filings cost money and draw unwanted attention, many companies opt for direct engagement with major shareholders, as discussed below.

Companies also need to stay abreast of any changes in the voting recommendation policies of proxy advisory firms.  For 2014, ISS has simplified one of the methodologies used when analyzing pay-for-performance to evaluate a company’s say-on-pay vote.  Currently, ISS measures the relative degree of alignment between the company’s total shareholder return rank and the CEO’s total pay rank within a peer group, as measured over both a one-year and three-year period.  For 2014, the one-year measurement period has been eliminated.4

  • Shareholder Outreach.  Shareholder outreach is an effective way for companies to learn about, and address, shareholder issues and concerns, strengthen the company’s relationship with its shareholders and lessen proxy advisory firm influence on investors.  Much of the success that companies are having with say-on-pay can be attributed to an increase in this engagement between companies and their shareholders.  But not all directors agree on whether they should be communicating with shareholders on executive compensation.  According to a recent survey, 34 percent of directors believe it is not appropriate for the board to engage in executive compensation discussions with shareholders, while 28 percent believe it is “very appropriate” and 37 percent believe it is “somewhat appropriate.”5
  • Compensation Committee and Adviser Independence.  New stock exchange rules kicked in on July 1, 2013 requiring compensation committees to conduct an assessment of the independence of compensation consultants, legal counsel and other advisers before selecting, or receiving advice from, such advisers.  The factors to be considered when determining independence are the same six factors that companies must consider when determining whether the company has a conflict of interest with any compensation consultant, which was a new proxy statement disclosure that took effect during the 2013 proxy season.  Although the new listing standards make clear that a compensation adviser does not have to be “independent,” compensation committees should ensure that they engage in the proper independence assessment and record the assessment in their committee minutes.

Boards should also be reviewing the independence of their compensation committee members to ensure the members qualify under new stock exchange rules that will apply on the earlier of (a) the company’s first annual meeting after January 15, 2014 or (b) October 31, 2014.  In addition to existing listing requirements, boards must also take into account all relevant factors when determining compensation committee independence, including –

–      the sources of compensation for each compensation committee member, including any consulting, advisory or other compensatory fee paid by the company, and

–      whether the compensation committee member is affiliated with the company, or a subsidiary or affiliate of the company.

  • Pending Dodd-Frank Regulations.  Much to the delight of companies, the SEC continues to lag in its rulemaking on several provisions required by the Dodd-Frank Act.  At a recent conference, SEC Chair Mary Jo White was noncommittal on the timing for these rules, but stressed the SEC’s commitment to deliver as quickly as possible.  In any event, companies should begin planning how they will implement and comply with the new rules once adopted.

–      Pay disparity disclosures.  The SEC finally proposed its long-awaited rules that would require public companies to disclose the ratio of a CEO’s annual total compensation and the median total annual compensation of all other employees of the company (including part-time, seasonal, temporary and foreign employees).6  The proposed rule provides companies with flexibility in determining the median compensation for employees by permitting the use of statistical sampling in order to ease the compliance burden.  This proposal sparked controversy even before it came out, with the SEC receiving nearly 23,000 pre-proposal comment letters.  And this controversy is likely to continue – with detractors questioning the rule’s utility and bemoaning anticipated compliance burdens and proponents touting the rule as providing meaningful information to shareholders.  Whatever the ultimate outcome, companies have some time to figure out how they will comply.  If final rules are adopted in 2014, a company with a fiscal year ending December 31 would be required to comply with the rules starting with fiscal year 2015 and first include the necessary disclosures in its Form 10-K, annual meeting proxy statement or a registration statement filed in 2016.

–      Pay for performance.  Another contentious provision in the Dodd-Frank Act calls for companies to disclose in their annual proxy statements the relationship between executive compensation and the company’s financial performance.  Although the SEC has yet to propose rules on this topic, companies would be wise to begin laying the groundwork in their 2014 proxy statements by showing a strong link between pay practices and performance.  Many companies have already begun drawing a stronger alignment between pay and performance by decreasing the use of options and increasing the use of time-based and performance-based restricted stock.  According to Equilar’s 2013 equity trends report, the percentage of S&P 1500 companies using option grants decreased for the fifth year in a row, from 78.5 percent in 2007 to 75.2 percent in 2012, while companies using restricted stock during the same period have increased from 80.1 percent to 92.8 percent.7

–      Clawbacks.  The Dodd-Frank Act also calls for the SEC and stock exchanges to implement rules requiring companies to develop and disclose clawback policies for the recovery of incentive-based compensation granted to any current or former executive officer during the three-year period preceding an accounting restatement that is based on erroneous data corrected in the restatement.  The language in the statute is broader than the clawback provisions in the Sarbanes-Oxley Act, which apply only to the CEO and CFO, have only a one-year look-back and require misconduct.  More and more companies are implementing some form of clawback policy in anticipation of the pending rules, and also to appease proxy advisory firms, which favor clawback policies.

  • Lawsuits on Executive Compensation.  The plaintiffs’ bar continued to torment companies throughout the 2013 proxy season by bringing lawsuits challenging the adequacy of a company’s proxy disclosures on executive compensation.  The lawsuits sought to enjoin either a shareholder say-on-pay vote or a vote to amend an equity compensation plan until the company makes additional disclosures.  In response to these lawsuits, many companies agreed to provide supplemental disclosures, and ended up paying six-figure settlements to plaintiffs’ attorneys to make them go away.  But recent victories by companies that decided to fight it out in court may have helped put an end to this line of cases.  Although these lawsuits will hopefully wane in 2014, companies would be wise to pay particular attention to their 2014 proxy disclosures to ward off whatever tactic the plaintiffs’ bar dreams up next.

This post was excerpted from our Top 10 Topics for Directors in 2014 alert. To read the full alert, please click here.

1   J. Carney, “Why ‘Say on Pay’ Failed and Why That’s a Good Thing,”, July 3, 2013.

2   PwC’s 2013 Annual Corporate Directors Survey at p. 16.

3  Id.

4  ISS, U.S. Corporate Governance Policy 2014 Updates (Nov. 21, 2013), pp. 7-9.

5   PwC’s 2013 Annual Corporate Directors Survey at p. 10.

6  Pay Ratio Disclosure Proposed Rule, SEC Release Nos. 33-9452; 34-70443 (Sept. 18, 2013) located here.

7 Equilar, 2013 Equity Trends Report at p. 5.